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Philippines: Opening Statement on the Philippine Economic Update, August 2014 edition

August 7, 2014

Rogier van den Brink, Lead Economist & Karl Kendrick Chua, Senior Country Economist Press Conference on the Philippine Economic Update, August 2014 Taguig City, Philippines

As Prepared for Delivery

Statement of
Rogier van den Brink, Lead Economist, and
Karl Kendrick Chua, Senior Country Economist

on the launch of the
Philippine Economic Update August 2014 edition


Good morning to everyone.

Our presentation is structured along 3 topics. First, we will discuss recent global and Philippine economic developments. Second, we will present the growth prospects for the Philippines. We will then end by discussing in more detail the medium-term agenda, especially as it relates to public investment.

In the June 2014 World Bank Global Economic Prospects, global growth projections were downgraded to 2.8 percent, from 3.2 percent in January.  The main reason for the downgrade was the anemic growth performance in the US in the first quarter of 2014. However, long-term prospects, in particular for developing countries still look good, but only if structural reforms efforts continue to be undertaken. We think that this global growth story is also very relevant for the Philippines.

Recent economic developments

After recording strong growth in the last 2 years, Philippine economic growth decelerated to 5.7 percent in the first quarter of 2014. This was due to the aftermath of Yolanda, lower government spending, and continued monetary policy tightening. For 2014 as a whole, growth projections are revised downwards from 6.6 to 6.4 percent for 2014 and from 6.9 to 6.7 percent for 2015.

Despite this slight downgrade, Philippine economic growth for 2014 is still projected to be one of the fastest among the major economies in the East Asia region, second only to China, which is projected to grow by 7.6 percent, and significantly higher than the regional average of 5 percent, excluding China.

Here is the breakdown of Q1 growth. On the supply side, the services sector continued to be the main driver of growth while agriculture remained weak. On the demand side, growth was driven by private consumption, durable equipment, and infrastructure spending. Moreover, the recovery of net exports after 5 quarters of contraction contributed to growth.

Their contribution, however, was muted by weak government consumption and the decline in private construction. The latter suggests that the real estate boom may be around its peak. This could be good news, as many observers have worried about the possibility of a real estate bubble.

More good news. After many years of slow poverty reduction, poverty incidence declined by 3 ppt between 2012 and 2013 to 24.9 percent, uplifting 2.5 million Filipinos from poverty. This significant reduction in poverty came after many years of weak poverty reduction when it averaged only 0.2 ppt annually between 2006 and 2012. Stronger job creation in the first half of 2014 suggests that faster poverty reduction is expected to continue.

Strong liquidity and credit growth, as well as higher food and energy prices, continue to pose some risks to price and financial stability. Food price increases account for more than half of the CPI inflation which is projected to reach 5 percent this year from 3 percent last year. Strong increases in the price of rice are particularly worrying, also because this hurts the poor disproportionally. These increases point to the need to quickly increase the importation of rice, which is under the government¡¯s management.

 Short-term growth prospects and risks

The growth projections will depend on the ability of the Government to fully and rapidly implement planned spending for typhoon reconstruction and other expenditure programs, in particular infrastructure. The key risks are domestic reform lags, in particular reforms to raise the tax revenues needed to sustainably increase infrastructure and social services spending.

A number of external factors also pose risks to growth. External risks come from monetary tightening in high-income countries, a hard landing of China¡¯s economic rebalancing, political tensions in the Middle East and Eastern Europe, and territorial disputes in the region.

 

Medium-term agenda

Moving forward, the challenge facing the Philippines is how to transform strong growth and macroeconomic stability into more inclusive growth¡ªthe type that creates more and better jobs and reduces poverty.

The Philippines has achieved so much in the last decade.

The economy has managed to sustain higher growth for over a decade now¡ªthe first time in 7 decades. In the last 10 years, GDP per capita grew by an average of 3.4 percent, much higher than the historical average growth rate of 1.4 percent from 1950 to 2003. This allowed the Philippines to double per capita income in just 7 years (from USD 1,660 to 3,270).

For the first time in 7 decades, the country recorded consistent current account surpluses. This is also providing a lot of stability.

For the first time in 7 decades, the country¡¯s inflation has generally been low and stable at less than 5 percent, allowing businesses and households to raise real income.

Finally, for the first time in 7 decades, the country has managed to lower debt-to-GDP ratio below 50 percent from over 100 percent in 2003. This allowed the government to double social services spending in the last 4  years, with strong impact on poverty.

Taken together, these are what we mean by strong macroeconomic fundamentals, the result of past and on-going reforms in the financial and public sectors. These have brought back investor confidence and led to credit rating upgrades to investment grade.

In addition to macroeconomic stability, the global and regional economic rebalancing, and the strong growth prospects of a dynamic East Asia region, are bringing in a lot of new opportunities to the Philippines.

Take for instance, the business process outsourcing industry, which grew from almost nothing prior to the year 2000 to over 900,000 employees in 2014 and contributed over USD 15 billion in revenues, with strong growth and employment impact to the rest of the economy. Today, Philippine call contact centers are number one in the world.

However, until recently, higher growth has not translated into more and better job creation and poverty reduction. While unemployment and underemployment have improved, there are still structural weaknesses that prevent the creation of a massive number of jobs.

Poverty between 2000 and 2012 was slow to decline, only falling substantially in 2013.

Around 75 percent of Filipino workers have at least one attribute of informality, such as the lack of a written contract, social or health insurance, and protection from dismissal.

Å·ÃÀÈÕb´óƬ ¡®s Philippine Development Report ¡°Creating More and Better Jobs¡± estimates that, relative to 2012, around 14.6 million Filipinos need to be provided good jobs by 2016.

Having achieved macroeconomic stability, efforts are now needed to boost shared prosperity. It is now time to take advantage of this period of stability and higher growth to ensure that all Filipinos benefit from these achievements. This can be done best by providing good jobs to all Filipinos.

More and better jobs can be created by pursuing structural reforms and investing more in human and physical capital. Key structural reforms include protecting property rights, promoting more competition, and simplifying regulations. These are discussed in the above-mentioned Philippine Development Report.

Let me discuss in detail one of these recommendations: raising investment in human and physical capital.

One of the major reasons why the country has not created more and better jobs is its low levels of investment in human and physical capital, alongside the lack of technological improvement.

In the past 4 decades, the overall investment trend was largely stagnant or falling. From close to 30 percent of GDP in the 1970s, investments declined to less than 20 percent of GDP in 2013. In the public sector, low tax effort and weak public investment management limited spending on infrastructure to less than 2 percent of GDP annually.

Another area of underinvestment is education. Due to perennially low revenues, the level of education spending has been lower than in some neighboring countries. For instance, Malaysia and Thailand spend between 1.2 and 2.5 ppt of GDP more than the Philippines, respectively. This low level of spending has led to lower quality of education.

Finally, lower public health spending has contributed to weaker health outcomes. Real per capita public health expenditures have been slow to increase while out-of-pocket health spending rose faster. As a result, progress towards meeting health Millennium Development Goals is mixed.

To raise investment in physical and human capital, higher and more efficient public spending, underpinned by improved revenue mobilization, is needed.

The government has successfully raised tax revenues by 1.2 ppt of GDP in the last 3 years through the sin tax reform, improved tax administration, and higher growth. Accelerating the current reform momentum would help the country yield additional tax revenues needed to enhance growth and raise household income in the coming years.

This can be achieved through a package of tax policy and administrative reforms. There is scope to increase tax revenues by broadening the base and making the tax system simpler, more efficient, and more equitable, while also lowering certain tax rates to increase the political feasibility of such a package.

On tax policy, a two-phased approach can be considered. In the first year, reforms can focus on policies that increase revenues, such as i) rationalizing fiscal incentives and enacting a tax expenditure ceiling; ii) reducing the number of VAT exemptions and instead using the national household targeting system for poverty reduction to protect vulnerable groups; iii) centralizing the valuation of real properties and enacting a national surtax if needed; and iv) increasing excise taxes on petroleum products once prices have fallen below a targeted threshold. These reforms will make the tax system simpler, more efficient and much more equitable.

In the second year, reforms can focus on i) reducing the corporate and personal income tax rates, ii) simplifying the tax system for small and micro enterprises and iii) consolidating all laws and regulations on tax incentives into one code.

These reforms need to be complemented by stronger tax administration and governance reforms, which would increase public understanding and support for tax policy reforms.

The realization of these reforms can help the country become more competitive, and in the process create more and better jobs, and accelerate poverty reduction.

With further economic reforms, especially in areas which will have more impact on the lives of the poor, the government can help put the country on an irreversible path of inclusive growth.


Conclusion

To conclude, the Philippines has achieved so much in the last decade. Many of us are benefiting from higher growth and macroeconomic stability. However, close to 25 million Filipinos still live below PHP 52 per day, the daily poverty line.

They urgently need our help. They deserve much better.

We need to share growth and job opportunities to all Filipinos. It is high time to invest more in the poor.

Thank you very much.

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